Financial Services Used by Small Businesses: Evidence from the 2003 Survey of Small Business Finances

Article excerpt

Small businesses--nonfarm entities with fewer than 500 employees--are an integral part of the U.S. economy. They account for about half of private-sector output, employ more than half of private-sector workers, and have generated 60 percent to 80 percent of net new jobs annually over the past decade. (1) Given the significant role of small businesses in the national economy, understanding trends in the types and sources of financing they use is important for economic research and policymaking, especially because small businesses typically finance their operations quite differently than large corporations do. For example, a small business often relies on the personal resources and credit history of the firm's owners to access credit.

Newly available data from the Federal Reserve Board's 2003 Survey of Small Business Finances (SSBF) provide detailed information on the use of credit and other financial services by these firms. The SSBF is the most comprehensive source of information available on the characteristics of small businesses and their owners; no other survey provides the breadth and detail of information for a nationally representative sample of such firms. Moreover, policymakers and researchers can compare the newest SSBF data with results from the previous surveys, which cover 1987, 1993, and 1998. Most of the changes reported in this article are for the period between the 1998 and 2003 surveys. (2)

The latest survey gathered data from 4,240 firms selected to be representative of small businesses operating in the United States at the end of 2003. (3) As in previous surveys, the data show that most businesses were very small and were located in urban areas. Also as in previous surveys, the percentage of firms involved in the provision of business and professional services increased somewhat, whereas the percentages of firms engaged in manufacturing and in retail and wholesale trade declined. Among firms that were corporations, those organized under subchapter S of the U.S. Internal Revenue Code (S corporations) continued to grow as a proportion of all small businesses relative to those organized under subchapter C (C corporations). (4)

The financial affairs of small business in 2003 were conducted in a financial marketplace whose elements--including regulations, technology, and organizational structures--have changed markedly since the Federal Reserve Board's first small business survey. For example, state and federal restrictions on interstate branching and banking have been relaxed, certain financial institutions are now permitted to offer a wider range of financial services, lenders employ complex credit-scoring models to evaluate would-be borrowers, and mergers and acquisitions have produced a financial industry with fewer but larger organizations.

In this changing financial marketplace, small businesses have been diversifying their providers of financial services. Nondepository institutions have become increasingly important sources of financial services to small businesses; more than half reported using nondepository sources in 2003, compared with about 40 percent in 1998. Among these sources, finance companies and leasing companies were important suppliers of credit and financial management services, especially for the largest small businesses, and brokerage firms were important suppliers of brokerage and trust and pension services. Nonetheless, commercial banks continued to be, by a wide margin, the supplier most commonly used by small businesses for checking and savings accounts, for loans other than leases and vehicle loans, and for financial management services other than brokerage and trust and pension services. They were the second most commonly reported provider of vehicle loans and trust and pension services.

The types of credit used by small businesses have also been changing. The percentage of firms that had outstanding vehicle loans and credit lines increased between the 1998 and 2003 surveys; the use of capital leases declined somewhat; and the use of equipment loans, mortgages, and other loans remained about the same. …